Interest Rates And The Market

Sometimes it is simply time for the market to either go down or march in place for a bit.  Consider the run we've seen since the Covid panic lows in the spring of 2020.  Equities of all stripes have posted stratospheric type returns.  Eventually those kinds of runs need to take a breather.  As time has passed we can now see that stocks have not done much for the past few months.  The S&P 500 is set to start trading today at levels last seen in about June.  This is hardly a catastrophe as the index is still up sharply for the year and only about 5% off of its most recent high.  In times of volatility, investors look for scapegoats.  That is they are looking for reasons why the market can go down.  Some of the prime suspects right now are inflation, budgetary issues in Washington, size of the Biden fiscal package, China and rising interest rates.  Let's quickly discuss the first four so I can spend a moment on interest rates.  

Inflation is worrisome but much of its issues stem from a world economy trying to get back on track after basically shutting down for a year.  Most of inflation's problems will likely go away when supply catches up with demand around the globe.  One way or another the Government will avert a debt crisis.  This same issue comes up about every two years and in the end everybody finds a way to keep the money presses rolling.  There will be a fiscal package and tax changes.  People are just arguing scope and size.  It will in the end be less than liberals want and more than conservatives are willing to spend.  That's just how it is and always will be.  China is the grand foreign policy challenge of the this century and will never be far off the back burner.  So now let's consider interest rates.   

The 10-year US Treasury bond trades at basically 1.50%.   A 30-year US bond yields slightly over 2% right now.  These yields are low, but have moved up about a quarter of a percent over the summer and are trading near highs seen in the past year.  This has sparked fears that perhaps interest rates will move higher in the coming months.  Now for the past year these low yields are one of the reasons that stocks have traded at valuation levels that would normally be worrisome.  At what level do interest rates become a problem for the stock market and the economy?  I don't know and obviously right now that seems like a problem off well into the future.  But think about it for a second.  We have borrowed trillions to fight the virus and will ultimately end up borrowing trillions more under the Democrat's fiscal proposals.  At what point do the public debts of the US start to concern the investment community.  My guess is you have to see the 10-year well over 2% and the long bond nearing 4% for bonds to start becoming serious competition for stocks.  That's probably not going to happen anytime soon.

When you buy bonds at such low yields as today what you are saying that you are willing to park your money in an investment that will likely not even keep up with inflation over the life of the bond just to get your principal back.  Contrast that with a simple S&P 500 ETF.  These currently have dividend yields slightly around 1.50% with a chance to also see those dividends grow over time.  You also get the potential for growth when the economy improves that has historically been in the 4-6% range.  If I had that choice then to me the obvious longer term choice is the ETF.  You do, however, have to be able to live with the market's volatility.  If you've done a proper asset allocation and have a solid understanding of your own personal risk/reward scenario this volatility is easier to live with.

*Long ETFs related to the S&P 500 in client and personal accounts.